Daqing was nothing but a vast, wild prairie in 1959.

Thousands of workers from all over the country moved to the area in Northeast China's Heilongjiang Province only to find no roads, no houses, not enough lorries, incomplete drilling equipment, and a shortage of daily necessities, China Daily reported Thursday.

It was a harsh time for China then and natural disasters had added to its economic woes. The workers, however, knew that they had no choice but struggle against the odds: They were carrying the whole country's hope of finding oil in Songliao Basin, a promising hydrocarbon bearing basin.

At that time, China produced little oil, and had to import it to satisfy demand. To prospect for oil, the newly-established Ministry of Oil Industry held the first conference on petroleum prospecting in 1956, insisting that power and labour be concentrated on locating reserves in those identified large basins.

Before long, a score of small oil fields were found at Karamay in the Xinjiang Uygur Autonomous Region and Qinghai Province. Despite these finds, production remained insufficient.

In 1958, the Ministry of Oil Industry urged three petroleum prospecting bureaux and organized thousands of workers to explore in Songliao Basin.This was to be the turning point for China's oil industry.

The Daqing oil men were determined. "Conditions aren't ready, but we'll create them!" they declared. The slogan became so famous that it inspired workers across China to develop the country.

One veteran who rose to prominence during the campaign was Wang Jinxi, a shepherd and coal bearer in his childhood, Wang went on to lead his team so hard he later became known as the "Iron Man" and a national hero.

Wang Jinxi and his drilling team let housing go and lived in tents, old cowsheds or shacks. Some dug underground shelters to sleep in. Equipment arrived by rail.

Without waiting for the cranes or lorries, Wang and his team unloaded 60 tons of drilling equipment themselves. Using their shoulders, crowbars and home-made tools they hauled it across the plain to the oil drilling site. Water pipes for the drill had not been installed so they fetched thousands of gallons from a lake some distance away. Battling against the odds and driven by a common fervour, the men sank Daqing's first well.

Incredibly, after five days of drilling they struck oil. That became the turning point in the history of the development of the oil industry in China.

Within three years, Daqing became China's first big oilfield. And by 1965, China had become self-sufficient in terms of oil products.

Starting from 1970, the Daqing field produced more than 50 million tons of crude a year, and maintained that level for more than two decades. The oilfield is the fourth largest in the world, and accounts for one third of the domestic production.

Production Increase

Thanks to large-scale prospecting in the Bohai Sea, some new oilfields with considerable reserves were found one after another during the 1970s, including Shengli, Dagang and Liaohe oilfields. These new fields enabled the output of China's crude oil to break the record of 100 million tons in 1978, thus joining other countries as major oil producers in the world.

Since the new policy of reform and opening up was adopted in China in the late 1970s, the third development stage of oil and natural gas prospecting has begun.

This cross-country prospecting has been conducted in the Tarim Basin, the Junggar Basin and the Turpan-Hami Basin in the west, the continental shelf in the Huanghai Sea and the East China Sea in the east, and the offshore areas in the South China Sea.

During the period from 1979 to 1996, the proven recoverable reserves of China's oil increased by 1.27 times over that of thirty years ago and natural gas 5.5 times.

In comparison with that of thirty years ago, the annual output of crude oil increased by 51.5 per cent and natural gas 46.5 per cent.

The annual output of crude oil in 1998 reached 160 million tons, while natural gas reached 23.2 billion cubic metres.

More than 20 bases for oil and gas prospecting and development had been established, and 20-odd large-scale petrochemical industrial enterprises founded with the crude processing capacity of 210 million tons a year.

As a result, the proportion of oil and gas production in the whole energy sector rose to 20 per cent from less than 1 per cent in 1949.

Oil production has remained stable since 1996 as many of the oilfields are ageing, while natural gas production increased much faster.

There is little prospect of increasing crude oil production from the ageing fields in China's eastern region, the main source of indigenous supply, but offshore production may increase in the near term. Recent new finds, many of them offshore, have made up for some of the falling output from Daqing and other mature giant fields.

Oil production increased by 1.5 per cent annually during 1998-2003, while natural gas production rose by 8.8 per cent annually. Oil production reached 166.9 million tons, and gas output rose to 34 billion cubic metres last year.

Rising demand

With the economy taking off, China's oil demand began soaring in the early 1990s.

Consumption has increased by 7.5 per cent per year since the 1990s, seven times faster than that of the US. China, which used to export several tons of crude to Japan, became a net oil importer in 1993. The imports, which now account for more than 40 per cent of the total consumption, are continuing to increase because of the country's industrialization and urbanization, plus the increase of automobiles on the road. Last year, China overtook Japan to become the world's second largest oil consumer just after the United States.

The net oil import of China rose from 1.247 million barrels per day in 2002 to 1.664 million in 2003 and 2.29 million barrels per day in the first quarter of 2004, the Paris-based International Energy Agency said recently. A barrel is roughly equivalent to 0.14 ton. By the end of July, China imported 70.63 million tons or 2.49 million barrels per day of crude this year, 39.5 per cent over the same period of 2003. It is estimated that the demand will continue to grow at 5 per cent or more annually in the coming years, leaving the imports even larger as the domestic fields age.

To tackle the challenge, the government is reinforcing the efforts for energy conservation, reforming the economic structure to reduce reliance on energy, and encouraging the oil companies to explore and develop resources at home and abroad.

Radical changes

The oil and gas sector was radically restructured in 1998 as the government moved to increase competition in the industry and push oil companies towards profit-oriented modern enterprises.

Refinery assets were transferred to China National Petroleum Corporation (CNPC), previously an oil and gas producing company, from China Petrochemical Corporation (Sinopec) in exchange for oil and gas producing assets. Thus, an oil producing company (CNPC) and a refinery company (Sinopec) were converted into two integrated oil companies. CNPC was assigned specific western and northeastern onshore and shallow water areas of China, while Sinopec was assigned specific southern and eastern areas onshore and in shallow water areas. CNPC received the areas considered to have the greater exploration and development potential.

China National Offshore Oil Company (CNOOC) retained offshore rights in water depths greater than 30 metres. China National Star Petroleum Corporation (STAR) made up of the exploration components of the Ministry of Geology and Mineral Resources (MGMR) retained rights to explore and develop resources in all onshore and offshore areas. Star was later merged by Sinopec. Both CNPC and Sinopec are gigantic in size. CNPC ranked 11th and Sinopec 20th among the world's top 50 oil companies in terms of 6 composite indices including oil and gas reserves, production, refinery and sales. Most provincial-level companies involved in oil and gas activities were integrated into Sinopec and CNPC. All the three oil companies were listed on the overseas markets, raising billions of dollars.

Regulatory functions were taken away from CNPC and Sinopec and transferred to various ministries such as the State Economic and Trade Commission, State Development Planning Commission (later the National Development and Reform Commission) and Ministry of Land and Resources. The main thrust of the restructuring is separation of business activities from regulatory components in the previously vertically integrated ministries' activities. This separation of regulation from business activities is part of the process to produce a level playing field for privately owned firms and State-owned enterprises.

The Ministry of Land and Resources has become the regulator of all land use in China. It has a target of implementing a certificate of title and permitted land use for all of China.

All mineral assets are the property of the State and only the three State oil companies are granted certificated rights to develop the mineral resources. Foreign-owned companies participate in the development of oil and gas through various types of partnerships with the State oil companies. The Ministry of Land and Resources now grants three levels of permission for exploration and development. They are a non-exclusive exploration permit which may include drilling a well, exclusive licensed exploration area and certificated development area.

Fees and time periods are specified for each level with the area decreasing as one proceeds to the certificated field development level. The individual State companies retain all data acquired in any area. Protection of the environment is carried out by the State Environmental Protection Administration.

The four State companies must obtain approval from the National Development and Reform Commission before completing an agreement with foreign oil companies for a joint venture. The State companies will discuss possible ventures and negotiate conditional agreements for joint ventures, subject to the approval of the National Development and Reform Commission.

In 1999, for the first time in the history of the Chinese petroleum industry, the companies are working towards profit targets instead of "plan volumes". And a new activity is being undertaken the evaluation of the profitability of individual fields and wells.

WTO

China entered the World Trade Organization (WTO) in 2001, and this is having an huge impact on China's oil industry.

China's major commitment to the WTO has three parts. Tariff reduction, relaxation on imports of oil products, and in the wholesale and retail market.

As required by the WTO, China's tariff on crude oil will be eliminated from a previous 6 per cent. Tariffs on gasoline will be lowered to 5 per cent from 9 per cent. And tariffs on diesel, kerosene and fuel oil will remain unchanged at 6 per cent, 9 per cent and 6 per cent respectively. On the distribution field, foreign companies will be allowed to run the retail business by the end of this year and wholesale business in 2006. On the import side, oil import restrictions are being dismantled in the wake of China's entry to the World Trade Organization by allowing more private and foreign importers into the market.

In the past, the government has used a quota system favouring imports of crude oil over oil products, in order to maximize domestic refining capacity. Only four entities are recognized as "State trading companies" when it comes to importing the vast majority of crude oil and refined products China National Chemical Import & Export Co (Sinochem), China International United Petroleum & Chemicals Co (Unipec, a division of Sinopec), China National United Oil Co (China Oil, a division of CNPC) and Zhuhai Zhenrong Co.

But in 2002, a certain amount of the total imports, 4 million tons of refined products, and 7.2-million tons of crude oil, were allowed to be imported by "non-State trading companies" companies that had successfully obtained import licences, but which were not necessarily State-owned or controlled. The new importers will be allowed to increase their crude oil imports by 15 per cent a year for the next 10 years. Their refined oil imports will also be allowed to rise by 15 per cent until 2004, when the import quota on refined oil is eliminated.

Price reform

As the sector is opening-up under WTO commitments, China is moving gingerly towards liberalizing its oil products market.

Beijing is now working on deregulating prices and eliminating entry barriers imposed on the domestic players. The government is mulling over reforms to the current pricing mechanism for refined products such as gasoline and diesel to better reflect market conditions.

Different proposals are being studied. These include regulating factory and CIF (Cost Insurance and Freight) prices, but not freeing wholesale and retail prices. Also regulating retail prices while liberalizing wholesale prices, and liberalizing retail and wholesale prices completely. The government is also likely to introduce price hearings a system that has been used in other monopolized industries like the aviation and railway sectors to ensure fair prices in two years. In the longer term, the government also plans to establish an oil futures market to accurately reflect domestic demand and supply, and oil prices.

The National Development and Reform Commission is now soliciting opinions from companies and experts over the price reform. If finalized, it will be the third time that China has revised its pricing system in five years, gradually giving up government control over prices to market forces.

In 1998, the government started setting benchmark retail prices for diesel and gasoline monthly, based on the average rates of the previous month on the Singapore market. The over-transparent pricing mechanism had resulted in massive speculation as dealers could easily calculate the prices and manipulate the market. It also led to frequent price fluctuations.

In 2001, the government scrapped the monthly pricing formula; it adjusted the benchmark prices only when the average price on the Singapore, Rotterdam and New York markets changes by "a certain margin" which is kept secret. The government also takes into account the condition of the domestic market when adjusting the benchmark price.

Meanwhile, it gave Sinopec and PetroChina a listing arm of CNPC more freedom to decide retail prices by allowing them to fluctuate 8 per cent up or down from the government-set benchmark. The previous range was 5 per cent. The problem, however, has now shifted from over-transparency to little transparency, said oil traders and companies.

Analysts said the pricing reform is also inevitable to accommodate the market trend of opening up. China is going to allow foreign companies to operate retail business by the end of this year, and wholesale business two years after that, according to its WTO commitment.

Meanwhile, China has allowed companies other than the four State-designated traders to import crude oil and refined oil products. With the opening-up of the market and more imports coming in, the government will lose control over prices, analysts said.

Apart from pricing reforms, the government is studying the abolishment of current restrictions on private companies entering the oil-product sector before it is fully exposed to foreign giants in December 2006. The move aims to give qualified private firms a level playing field, and provide a testing ground to prepare Sinopec and PetroChina to meet the impending foreign competition, experts said.

According to current regulations, only the Big Two companies (CNPC and Sinopec) are allowed to build new gasoline stations. They are also the only companies to run wholesale distribution business. The government had imposed the restrictions so that the two companies could get a better grip on the market and sustain prices to underpin the revenues at their lumbering refineries, which are especially important to the national economy as they absorb millions of workers and contribute billions in tax revenues. With government support, and their massive acquisition of private and local government-owned filling stations, the Big Two have increased their share in the retail market to over 50 per cent from less than 40 per cent. They also control over 90 per cent of the wholesale market.

But there are signs that the government is trying to relax the restriction.

Shanghai-listed Hubei Tianfa Group, a refined-oil-products trader, announced that it had obtained a wholesale licence for its products.

It is the first granted by the government in four years after thousands of such licences were recalled and the business consolidated into PetroChina and Sinopec in 1999. But the participation of private firms will not particularly rock the sector, since PetroChina and Sinopec still control oil supplies at the wholesale level, and most storage facilities, traders and experts said.

As for the retail network, petrol stations are dependent on where storage facilities are located, and the "Big Two" have almost all the best places.

Traders said the market scenario is also unlikely to change overnight, even though China is going to drop the quota system for State trade of refined oil products by the end of this year. Even though private firms are allowed to import, they cannot handle imports without storage depots along the coastline, where Sinopec and PetroChina control most of the tanks and storage facilities.

A truly competitive market would only take shape after 2007 when the market is completely opened up. China will open its retail distribution markets fully to foreign oil companies in 2005. Wholesale markets will follow in 2007.

Overseas firms

Foreign companies, mainly the biggest three BP, ExxonMobil and Royal/Dutch Shell are operating both upstream and downstream business. On the upstream, foreign companies are mainly co-operating with China National Offshore Oil Corp to explore and develop oilfields in China's offshore areas. Downstream, they are investing billions of dollars in building world-class refineries and petrochemical complexes with Chinese partners in Guangdong, Jiangsu provinces, and Shanghai.

Meanwhile, foreign companies are cracking open the lucrative retail market following China's entry to WTO. Two British oil giants BP and Royal Dutch/Shell have sealed contracts to form separate JVs with Sinopec and PetroChina to build and operate 1,500 service stations in the booming coastal provinces of Zhejiang, Jiangsu and Guangdong in the next three years. It is widely believed that ExxonMobil's similar JVs with Sinopec will soon be approved by the government.

The long-awaited deals illustrate that China is officially allowing foreign companies into its once tightly-controlled and lucrative retail market for oil products.

There are less than 300 foreign-funded petrol stations among the nation's more than 80,000 outlets. Most of them were built before the government banned such investment several years ago. The impact of the new foreign JVs on the market dominance of Sinopec and PetroChina would be limited, for the time being.

The two domestic oil companies will control the wholesale oil supply to service stations for the next two years, until the market opens.

Source: China Daily